When starting a company, founders often focus exclusively on making sure that products can be developed, that customers or clients can be found, and that the company generally has a strong growth trajectory. Other areas may be harder to focus on when the company is in its infancy — but they are no less important. One such area is deciding how to allocate stock to and among the founders of the company. This decision could seemingly be made once the company is off the ground and more profitable. However, founders should use the company’s infancy as an opportunity to not only allocate shares, but also clarify roles, responsibilities, and expectations among themselves and early employees. Allocating stock as the company grows and the shares increase in value will be more difficult down the line.
Allocating to and Among Founders
Allocating to founders refers to how much stock should go to the founders of the company relative to the total amount of stock outstanding. Allocating among founders assumes that more than one individual can be considered a “founder” and refers to how those founders should allocate the stock among themselves.
The key here is balance. Founders are allocated a large portion of the company’s stock due to their contributions to the company and as an incentive to continue service to the company. However, the founders’ percentage of ownership will change over time depending on the number of employees, rounds of investment, and general company growth.
Although no “perfect” balance exists, conventional wisdom says that at incorporation, when a company has no investors, 80%-90% of the stock is typically allocated to the founders, with the remaining 10%-20% of the outstanding shares reserved for grant under an equity incentive plan. Depending on the specifics of the company, the founders, the employees, and the investors, the allocation to the founders may be higher or lower. However, these numbers are a good place to start when thinking about how to allocate shares to founders. Founders can iron out the details using a simple pro forma cap table to see how changes in allocation will affect other stockholders.
Allocating shares among founders at the outset of the company is extremely important. Unlike the allocation of stock relative to investors and employees, the ratio of stock allocated among founders will likely not change as the company grows, unless there is an agreed upon change or a founder leaves the company. Determining the founder stock allocation represents a great opportunity to clarify roles and responsibilities and set expectations among the founders.
There are multiple schools of thought on this topic. Some believe that founder stock should be split equally. Others feel that the distribution should not be equal because it can lead to stalemates, which can kill a young company. Generally, however, in making this decision, companies should consider a variety of factors to determine what each founder is bringing to the company and how to allocate shares. These factors include:
- Who had the idea and/or is contributing patented technology
- Who is formulating and executing the business plan
- Who has expertise in the industry, including connections to investors and other contacts
- What levels of responsibility are held, e.g., who will be working for the company full- or part-time
Capital contributions to the company generally should not play a role in the distribution of stock among founders. Allocating founder stock based on actual work contribution (“sweat equity”) and treating the founder who contributed capital as an investor, with shares being issued to them from those shares allocated for investors, is often a better arrangement.
This article does not contain an exhaustive list of how to allocate shares, but simply offers some considerations. Consulting with founders of other companies, lawyers, consultants, or other peers and advisers can help inform the founders stock allocation. Ultimately, the individuals starting the company will decide what is best for the founders and the company. This may be a difficult or uncomfortable process, but an important one to undertake at the outset to avoid problems in the future.
